Viewing entries tagged
gains and losses

Kick the Losers To The Curb

No doubt that as the capital markets start out 2014 either moving down or barely managing to tread water, our thoughts normally turn to "what do I own right now that I probably shouldn't?" I can hear the trades taking place even as I write this blog. 

But venting out the old in favor of the new may not be the best option that you have at your disposal. 

We always tend to pay and invest too much credibility in short term data.  And, that disconnect is off at more than one level.  If we have "long-term" goals then why wouldn't we match that with a view based on long-term data instead. 


In a recent blog post, Behavior Gap expert Carl Richards formulates a cogent argument for continued diversification based on the principal that what was once performing well, will one day not be and likewise, what was once not performing well, will one day be doing just that. 

In a seminal book on Asset Allocation, portfolio manager and financial advisor Roger Gibson noted that on average, your portfolio should at least be aligned in a manner consistent with overall global asset distribution. So, whether your emerging market stock or bond funds are performing well or not, they deserve a place among a well diversified portfolio and that level of representation in your portfolio should match your risk propensity and tolerance. While I don't think that emerging markets should dominate, surely they should be represented in your holdings and at a level consistent with your risk tolerance. 

My best bet would be this; if we look at past successful "investors" or "portfolios" or "Clients" we're going to find two things that really account for much of their long-term success; 

1. They tend to stay the course and invest more in a sound process than short-term data, and; 

2. They do the things that most people are not willing to do, they put money in when markets are declining and frankly, that means your betting on your losers, not getting rid of them

It's hard to argue that for many 401k plans are viewed as their most successful investment.  But can we tell why that's the case?

For many, it's their only savings plan, I get that, but that's not necessarily what makes it the most successful. I'll offer a counter claim to the success; 

1. Because contributions are made out of each payroll period, money goes in no matter what, and; 

2. Because investment options are so damn hard to discern for the average investor they're more likely to just stick with the allocation that they chose when they started and not monkey around with it all that much

That captures two important initiatives; 

1. Doing what most people won't do (making contributions to investments in declining markets) and; 

2. Staying the course

As an advisor I understand more than most the desire to avoid market declines and feel that we can side step adversity and it's easy to be fooled that we can.  Let me give you a real story to support that. 

A few years ago, we had a Client that demanded that they go to all cash during the very end of the 2008 decline. No matter what we did we couldn't convince them that staying the course was their best option. So, we agreed in the end that we'd move them to cash. That was the easy part; getting out is always the easy part. 

What we struggled with was getting them back in.  It never, to their way of thinking, seemed like the right time to put the money back in the market. They missed the first 11% of the run up that followed the rebound that started in 2009.  When we finally were able to convince them to get back to fully invested, we asked the following question?

"If, by getting out of the market we prevented a 3% decline and missed an 11% run up on the other side, didn't we effectively make avoiding a 3% loss into an 8% loss?"

We did. But you can't believe how hard it was for us to convince our Client of that fact. To their way of thinking, they avoided a loss.  Math would indicate that exactly the opposite occurred, they created a larger one. 

If the value of diversification is real, which it is, then one other factor remains immutably true about your winners, your losers and investing in general; 

"If they don't ring a bell to tell you when to get out, they sure as hell don't ring one to tell you to get back in....."

Change your way of thinking...your losers aren't your losers, they're your "just not making money now" assets.

December Will Be Taxing.....or maybe not.

As the year draws to a close, it’s normal that our attention would be turned to income tax management. 

What’s not normal is that this year, if the laws play-out as they’re legislated, we’ll be turning the tax world upside down. 

Normally, we’d be looking to take tax losses and postpone gains, however, this year we’d be looking to do just the opposite, we’d be looking to take gains and shove those losses out a bit. That’s because the capital gains rate is expected to go up in 2013 as are the overall tax rates, that means your losses (if you have them) would be more valuable to you under next years tax rates than they would under this years rates.

Sounds easy enough right? Oh, if it were only that easy......

There’s actually a continuum of options: 

  • lower bracket tax payers who enjoy a zero percent capital gains rate this year want all the gains they can get. Next year they’re rate increases on capital gains exponentially
  • middle bracket tax payers, those in the 28% bracket want to take their gains too with this caveat, the best candidates for tax planning this year are middle bracket taxpayers who have little to no carryover losses from previous years. That’s because you MUST take your losses if you have them (which you’d be taking at a lower tax rate and you don’t want to do that) against your gains
  • high bracket tax payers likely too want to take their gains because their capital gains tax rates are lower this year than they’ll be next year but again, that makes sense only if they don’t have carryover losses from previous years for the same reason as noted above for middle bracket taxpayers

Bottom line is that you need to have the details of your personal situation on hand in advance to aid in your decision making, here’s what we recommend; 

  1. Know you gain and loss positions by early December and evaulate what can “go” and what can “stay” 
  2. Contact your accountant or tax preparer and ask them what amount of carryover losses you had when your return was completed last year
  3. Ask your accountant or tax preparer what your marginal tax bracket was last year and what they think that it’ll be this year and if you’re in the lowest brackets
  4. By Mid-December, finalize a strategy that you’re comfortable implementing to get the biggest tax bang you can

By the way; our Mid-December recommendation isn’t one we pulled out of our hat. Odd are you’ll get interim legislation before the Christmas recess on either new final regulations or the inevitable changes that are slated for change on December 31st. 

Either way, you’ve got to have a strategy ready in time. 

Of course if the rules change before year end, this could have been for naught but better to be safe than sorry. 

If you have any questions, email us by using our Contact form here and we’d be happy to give you our feedback. 

Note: Barry Capital Management clients have this process already being taken care of as part of our Wealth Management program offering.